Note 11 - Income Taxes

The Company uses the asset and liability approach to account for income taxes. Under this approach, deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and net operating loss and tax credit carry forwards. The amount of deferred taxes on these temporary differences is determined using the tax rates that are expected to apply to the period when the asset is realized or the liability is settled, as applicable, based on tax rates, and tax laws, in the respective tax jurisdiction then in effect.

Dynasil Corporation of America and its wholly-owned U.S. subsidiaries file a consolidated federal income tax return and various state returns. The Company’s U.K. subsidiary files tax returns in the U.K. Prior to November 18, 2016, the Company’s subsidiary, Xcede was included in the federal and state tax returns filed by Dynasil. As of November 18, 2016, Dynasil’s ownership in Xcede was reduced to approximately 59%. As a result, Xcede will no longer be included in Dynasil’s federal consolidated tax return and will file a separate federal return. Xcede will continue to be included in the Dynasil consolidated state tax filings pursuant to the respective state tax requirements.

In assessing the ability to realize the net deferred tax assets, management considers various factors including taxable income in carryback years, future reversals of existing taxable temporary differences, tax planning strategies and projections of future taxable income, to determine whether it is more likely than not that some portion or all of the net deferred tax assets will not be realized.

As a result of Xcede’s de-consolidation from the Company’s federal tax returns, the Company will no longer be able to offset taxable income with Xcede’s current or cumulative net operating losses. Upon review of relevant criteria for the new Dynasil federal consolidated group, it was determined that it is more likely than not that the federal deferred tax assets of the new Dynasil federal consolidated group will be realized based upon positive earnings history and expected future profits of the group. As a result, the federal deferred tax asset valuation allowance associated with the Dynasil federal consolidated group was reversed resulting in an income tax benefit in the amount of $2.7 million during the quarter ending December 31, 2016. Going forward, as the Company records income, it will be able to utilize the NOLs (net operating losses) within its deferred tax assets. Based upon the Company’s recent losses and uncertainty of future profits, the Company has determined that the uncertainty regarding the realization of the Company’s state and separate Xcede deferred tax assets is sufficient to warrant the continued need for a valuation allowance against these deferred tax assets.

The Company applies the authoritative provisions related to accounting for uncertainty in income taxes. As required by these provisions, the Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more-likely-than-not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being reached upon ultimate settlement with the relevant tax authority. As of March 31, 2018 and September 30, 2017, the Company has no liabilities for uncertain tax positions. Interest and penalty charges, if any, related to uncertain tax positions would be classified as income tax expense in the accompanying consolidated statement of operations. As of March 31, 2018 and September 30, 2017, the Company had no accrued interest or penalties related to uncertain tax positions. The Company currently has no federal or state tax examinations in progress.

On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was signed into law. The Tax Act, which is effective on December 22, 2017, significantly revises the U.S. tax code by, among other changes, lowering the corporate income tax rate from 35% to 21%, requiring a one-time transition tax on accumulated foreign earnings of certain foreign subsidiaries that were previously tax deferred and creating new taxes on certain foreign sourced earnings. At March 31, 2018, the Company has not completed its accounting for the tax effects of the Tax Act; however, the Company has made a reasonable estimate of the effects on its existing deferred tax balances and the one-time transition tax. The Company is reviewing and will continue to review its accounting of the tax effects of the Tax Act through the end of the fiscal year.

The Company re-measured certain U.S. deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21%, and provisionally recorded an income tax expense of $0.5 million related to such re-measurement in the first quarter of fiscal 2018. It is still analyzing certain aspects of the Tax Act and refining its calculations during the measurement period.

The one-time transition tax is based on the total unremitted earnings of the Company’s foreign subsidiary, Hilger, which has previously been deferred from U.S. income taxes. The Company recorded a provisional amount for its one-time transition liability of its foreign subsidiary resulting in additional income tax expense of $0.2 million in the first quarter of fiscal 2018. The Company has not yet completed its calculation of the total unremitted earnings of Hilger. The transition tax is based in part on the amount of those earnings held in cash and other specified assets. The amount may change when the Company finalizes the calculation of Hilger’s total unremitted earnings previously deferred from U.S. federal taxation and finalize the amounts held in cash or other specified assets.

There are Research and Experimentation tax credits available at both the federal and state levels resulting from the PATH Act of 2015 (“PATH 2015 R&E Tax Credit”). These credits are designed to encourage and reward companies for efforts in areas of research and experimentation. In March 2018, the Company has reasonably completed a study encompassing all business activities and contracts in these areas for the years 2012 through 2016. As a result, the Company is estimating it will have net tax credits of approximately $1.3 million on its federal income tax returns for the years ended September 30, 2012, 2013, 2014, 2015 and 2016. The Company is in the process of reviewing its state tax credits and will have those results completed and additional credits determined by year end for the same time periods.

The effective tax rates were (3,586%) and (148%) for the three months ended March 31, 2018 and 2017, respectively. The effective tax rates were 281% and 6,995% for the six months ended March 31, 2018 and 2017, respectively. The results for both six month periods ended March 31, 2018 and 2017 had significant events which resulted in an extreme variation in tax rates. The effective tax rate for the six months ended, March 31, 2018 was primarily driven by the recently signed 2017 Tax Act, as well as the R&E tax credit study completed in the second quarter of fiscal year 2018. The effective tax rate for the six months ended March 31, 2017 was primarily the result of the tax benefit of $2.7 million recorded for the release of the valuation allowance as a result of the tax deconsolidation of its Xcede subsidiary. The effective tax rate excluding the impact of the 2017 Tax Act was (16%) for the six months ended March 31, 2018. The effective tax rates excluding the impact of the 2017 Tax Act, the R&E tax credit and the valuation allowance were (43%) and (437%) for the six months ended March 31, 2018 and 2017, respectively.

The Company files its tax returns as prescribed by the tax laws of the jurisdictions in which it operates. The Company’s tax filings for federal and state jurisdictions for the tax years beginning with 2014 are still subject to examination.